Nº 22-28: Domestic Climate Policy and Cross-Border Lending

We document that banks respond to higher domestic climate policy stringency by extending relatively more cross-border lending. Using loan fixed effects to control for loan demand, we find that the positive effect increases as the borrower country becomes less stringent and is absent if the borrower country is more stringent, consistent with a race to the bottom. Furthermore, climate policy stringency decreases loan supply to domestic borrowers with high carbon risk while increasing loan supply to high-risk borrowers abroad. Our results suggest that crossborder lending enables lenders to exploit the lack of global coordination in climate policies.